Fitch Revises Its REIT Outlook Down to Deteriorating

Like other segments of the CRE market, REITs have been buffeted by tighter lending conditions, higher interest rates that put pressure on valuations and fundamentals, and macroeconomic headwinds. Surveying the battlefield, Fitch Ratings has slashed its 2023 outlook for REITs from “neutral” to “deteriorating.”

Lending by banks, which Fitch says represent about half of the $5.5 trillion commercial mortgage market, dropped 20% from February to April this year, and tightened again in May. Expected further contractions in CRE credit will limit opportunities for transactions.

Even so, Fitch believes most of the REITs it rates “have the capacity to withstand such a slowdown within rating sensitivities.” Some “with ample dry powder” could even find opportunities to bargain hunt by capitalizing on distressed property sales. 

On a slightly more cheerful note, Fitch says, “We have pushed out our forecast for a U.S. recession to late 2023 from mid-year and fundamentals for stronger performing property types have generally exceeded our expectations, while struggles are mounting for weaker performing sectors.”

Fitch predicts wide variations in performance by property type over the next two years, though none will be unscathed. “The office REIT sector has met, or modestly underperformed, our low expectations during 2023” the report states, caused by concerns about the business cycle as well as remote work.  “The industrial sector, although no longer white hot, continues to deliver above average occupancies and outsized rent growth that have modestly exceeded our projections.” Nevertheless, Fitch expects demand in this sector, as well as shopping centers, to cool somewhat as tenants hold back.

“REITs with de-levering strategies that depend on favorable capital market conditions and a robust disposition environment could face downward rating pressure,” Fitch cautioned. However, it does not expect the turmoil in the banking system to result in “meaningful stress.” Nor does it anticipate that REITs’ access to unsecured revolvers will be impeded. But renewals could face higher pricing and some banks may be reluctant to undertake traditional bank syndicate activities, such as making funded term loans.

Fitch anticipates that REIT senior unsecured issuance will remain subdued for the rest of the year. After reaching levels of around $74 billion in 2020 and 2021, it slumped to around $28 billion in 2022 due to rising interest rates. To date, Q1 2023 has been the weakest in five years at just $10 billion.

On the positive side, Fitch noted, “most REITs proactively managed their liabilities, utilizing the low-interest-rate environment of the past decade to term out debt and increase balance sheet flexibility.”